For Johnson Controls, a Split Creates Opportunity, Vulnerability

NEW YORK (The Deal) -- Johnson Controls (JCI) is shifting back toward its roots with its announced move to separate its massive automotive unit and focus instead on building controls and energy storage. But management still has considerable work to do once the auto business is gone if Johnson Controls hopes to stay independent for another century.

Milwaukee-based Johnson Controls said Wednesday it has retained Goldman Sachs (GS) and Centerview Partners to explore options for the automotive business, a collection of seating and related assets that accounted for about 40% Johnson Controls' $43 billion in 2014 sales.

The planned split is the latest in a series of sales for Johnson Controls, which in March said it would sell its facilities business to CBRE Group (CBG) for $1.48 billion, and in years past sold its HomeLink unit to Gentex Corp. and its auto-electronics assets to Visteon (VC).

The resulting company will be focused primarily on battery and energy-storage technology and its building efficiency business, which makes HVAC systems and related controls for residential and commercial properties.

Splitting off what remained of autos had long been seen by Wall Street as the next natural step, with the company in recent years focusing much of its research and development budget in areas other than seating. Johnson Controls management said it is open to an outright sale, spinoff or formation of a joint venture to shed the unit, with a decision expected before year's end.

The company may find it easier to spin the unit off than find a buyer. The seating business grew through a series of deals beginning in the mid-1980s, and over time Johnson Controls has blended different units together and divested certain pieces, making the tax basis difficult for outsiders to calculate. But even if tax issues can be mitigated, the most likely buyers are companies that already have a substantial presence in the seating business. Rivals including Lear Corp. (LEA) and France's Faurecia (FRCUF) would likely face regulatory issues.

If an industry buyer does emerge, Magna International (MGA) would seem to be the most likely suitor. The Canadian supplier has a smaller share of the seating market than its rivals do, and has said it hopes to expand the business. Magna didn't immediately return a request for comment.

A private-equity firm could also show interest, perhaps hoping to build on Johnson Controls' auto interiors joint venture with an affiliate of China's Shanghai Automotive Industry Corp.

Without automotive, Johnson Controls will feel pressure to enhance the remaining businesses, and even with a spinoff, the separation should leave the company with ample dry powder to pursue acquisitions. The parent is likely to shed some of its debt onto the new company, and UBS analyst Colin Langan said Johnson Controls "would likely gain some ability to lever up further given a less cyclical remaining business."

Nomura analyst Jonathan Wright estimates that Johnson Controls post-split could have upward of $10 billion in potential firepower, including debt opportunities. He said the company could pursue a large deal that would round out its building product line, perhaps something related to fire and security, or expand the portfolio and distribution capabilities of its mid-sized commercial HVAC business.

Though the building segment is attractive as it is expected to benefit from a rebound in construction and a desire by existing owners to upgrade their properties, the operation to date has failed to match the margins generated by its peers. A deal to add scale and offer more cross-selling opportunities could help solve that problem.

Perhaps Johnson Controls could add the security unit of Stanley Black & Decker (SWK), a perennial divestiture candidate that Stanley has hinted could be on the block by the time the Johnson Controls breakup is complete. Or a slimmed down Johnson Controls, presumably post-split worth well less than its current $35 billion market capitalization, could be a target for a company such as Honeywell (HON) or Germany-based Siemens (SIEGY).

Johnson Controls began in the 1880s as a maker of electric room thermostats before diversifying first toward batteries and telegraphs and eventually into automotive. The auto chapter might soon be over, but expect the transformation to continue.

Read more from:

More from Mergers and Acquisitions

Attention 60 Minutes: Google Isn't the Only Big-Tech Monopoly

Attention 60 Minutes: Google Isn't the Only Big-Tech Monopoly

Apple Buys Tesla? Amazon Buys Sears? 3 Dream Mergers That Just Make Sense

Apple Buys Tesla? Amazon Buys Sears? 3 Dream Mergers That Just Make Sense

Square Shares Shake Off Concerns About PayPal's Deal for iZettle

Square Shares Shake Off Concerns About PayPal's Deal for iZettle

It's a Family Feud - CBS is Granted Restraining Order Against Shari Redstone

It's a Family Feud - CBS is Granted Restraining Order Against Shari Redstone

How Qualcomm's CEO Is Helping Steer the Shift to 5G

How Qualcomm's CEO Is Helping Steer the Shift to 5G